The Lehman Brothers Debacle Illustrates the Extent of the Global Credit Collapse

Saturday, Sep 13, 2008

You probably saw yesterday's headline in The Wall Street Journal: Lehman Races to Find a Buyer. Well, well. The once mighty Lehman Brothers Holdings firm had a market capitalization of $47 Billion last year. But when I last looked, it was down to a paltry $2.58 billion. The company is now definitely on the ropes. It is likely that the Mother of All Bailouts (MOAB) is going to grow even larger. There will probably be an announcement made this weekend of a "private" takeover of Lehman--possibly including an overseas "white knight"--but down in the fine print we will learn that the deal will all be guaranteed (directly or more likely indirectly) with funds from either the Federal Reserve or the U.S. Treasury. (For now, Federal officials assert that they are merely "helping" to arrange a private sale.) Does this sound reminiscent of the Goldman Sachs bailout, around this time last year? Methinks they'll use the same mechanism.

Stepping back a bit, it is apparent that the Lehman Brothers debacle is merely symptomatic of a global credit market that is badly broken. Liquidity has dried up more than at any time in living memory, and companies are desperate for working capital. The Lehman failure will not be the last collapse of an investment bank, nor the largest. In my estimation, the liquidity collapse will continue, taking down some of the titans of Wall Street, in the process. As assets collapse in value, creditworthiness shrinks, and margin calls are made, in a widening death spiral. I believe that it is very likely that in the months to come, you will hear of huge derivatives failures, with vanishing counterparties leaving the other half of the "perfectly balanced risk sharing" model twisting in the breeze. There will be huge hedge funds that go belly-up, leaving their investors with little or nothing. First will come word of hedge fund redemption suspensions, followed by news of fund collapses, followed by news of pennies on the dollar settlements, or perhaps no pay-outs whatsoever. Keep in mind that these funds are not FDIC insured, so hedge fund investors could lose everything.

Watching this slow-moving avalanche will be agonizing, and last for years. As I've written before, it will be impossible to predict when it will end, because nobody can gauge where the "bottom" is, as entire asset classes lose more and more value. Up until now, most of the media attention has been focused on residential real estate. But for more than a year, I've been waiting for the other shoe to drop: commercial real estate. As the recession continues and companies tighten their belts and begin laying off employees in earnest, a drop in commercial real estate is inevitable. Next we'll hear of stock market declines, and perhaps a full scale collapse of share prices. Then will come municipal bond failures, and both private and public pension fund failures.

Depending on how long the downward cycle continues, this could make the Great Depression of the 1930s seem mild, by comparison.

Be ready. Be prepared to lose your job. Now might be the time to think in terms of secondary streams of income. Build up a home-based business so that you will be able to meet your basic needs and pay your property taxes. If you haven't done so already, then get out of debt. Free up as much cash as possible by selling your collectibles, your vacation property, and your "Big Boy Toys". (What is more important: to you? Your neighbors admiring a fancy Jet Ski in your carport, or feeding your family?) Sell your sports car, and buy a beat-up ut mechanically sound Saturn or Toyota Corolla. Cash out of most of your US dollar-denominated investments. After paying down your debts, put the cash that is generated into a one year storage food supply and some practical, liquid tangibles. It is essential that you do not hesitate. If you wait another few months, the prices of "fru-fru" collectibles will plummet. Sell them now, while they are still worth something. Prepare and stand ready to provide for your family, regardless of what happens beyond your control. It is your responsibility to prepare.

The Memsahib Adds: In the context of all this talk of gloom and doom, I must add that it is important to maintain balance, perspective, and a positive Christ-centered outlook. Take time daily to enjoy the blessings of your family and friends. Don't obsess on the darker aspect of the "what if?" future to the point that you stop enjoying life and make those around you miserable. Husbands in particular, take note: Prepare so that you can provide for your families, but don't forget to enjoy the blessings that we enjoy in the present day. Keep in mind Ecclesiastes 9:7-9:
"Go then, eat your bread in happiness and drink your wine with a cheerful heart; for God has already approved your works.
Let your clothes be white all the time, and let not oil be lacking on your head.
Enjoy life with the woman whom you love all the days of your fleeting life which He has given to you under the sun; for this is your reward in life and in your toil in which you have labored under the sun."


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